Are Saving More and Working Later the Only Options to Improve Retirement Readiness?

In
a Pension Research Council working paper, Catherine Reilly, senior investment
strategist, defined contribution, at State Street Global Advisors (SSGA), and
Alistair Byrne, head of investment strategy, European defined contribution, at
SSGA, state that expected low market returns paired with increasing longevity
will make it tougher for future retirees to have sufficient income replacement
rates in retirement.

After
performing an analysis based on certain assumptions so that only the effect of
lower expected market returns is measured, the researchers find that a hypothetical
individual currently 60 years old and who retires at age 65, having been saving
since age 22, could expect to achieve a 211% replacement rate from his defined
contribution (DC) savings alone. In addition, he can expect to receive Social Security
and may well have some defined benefit (DB) plan benefits as well. The paper authors
note that while few 60-year-olds may have been in a DC plan since the age of 22,
they could have made contributions to a retirement savings account by
themselves.

By
contrast, an individual currently 25 years old and who employs the same saving
strategy could expect to achieve a 27% replacement rate from his DC plan if he was
to retire at age 65. Furthermore, the younger individual is unlikely to have any
DB entitlements and faces more uncertainty regarding the amount of Social Security
that he will receive. The researchers note a 45-year-old individual can expect better
outcomes than the 25-year-old but is also disadvantaged compared to the 60-year-old.

The
researchers contend that the most obvious tactics that younger workers could adopt
to improve their situation are to contribute more and to work longer. For
example, a 25-year-old could reach a 40% replacement rate by contributing about
13.5% and working until age 65; by contributing slightly above 10% and working to
age 70, or by contributing about 7% and working to age 75. A 35- or 45-year-old
benefits from stronger historical returns, so either can achieve the target
replacement rate at slightly lower contribution rates. The researchers also
note that individuals who start the retirement saving journey late face more
challenges, yet they can also significantly improve their retirement readiness with
a disciplined approach to saving and by postponing retirement.

However,
this assumes consistent savings behavior during the entire working life, no
career breaks, and no leakage from retirement savings.

NEXT: Suggestions to Improve Retirement Readiness

The
researchers suggest policy changes that could improve retirement outcomes for
younger individuals and/or late savers. One alternative policy would be to allow
individuals to take out partial Social Security benefits rather than obliging
them to always take the full benefit. For example, the paper notes, in Sweden, people
who have reached the minimum age of eligibility for Social Security (62) can
take a 25%, 50%, 75%, or 100% benefit, and modify this percentage when desired at
an actuarially fair rate. There is also no maximum age by which full payments must
start. Another option would be to give people a choice to defer the start of
Social Security benefits beyond age 70, to make the most efficient use of Social
Security’s cost-efficient longevity insurance. “This would make it possible to
use Social Security as a longevity backstop providing the main source of income
in late life, rather than a steady source of income throughout retirement,” the
paper says.

As
an example, the researchers note that in Australia, eligibility for the Age
Pension is based on an asset test, reassessed annually, rather than retirees’
age. People are not eligible for the Age Pension until they have drawn their
assets down to a minimum level, after which they receive a flat rate Age
Pension for the rest of their lives.

Other
than Social Security policy changes, the researchers suggest mandating
automatic enrollment in DC plans and automatically escalating contribution
rates would be effective for improving retirement outcomes. In addition, they
note that matching contributions encourage voluntary employee contributions up
to the match threshold. Reducing retirement plan leakage would also be helpful.

The
researchers note that although some people may not be physically able to work
full-time past retirement age, part-time work may be feasible for many. A question the researchers posed, but did not
address fully is how employers will facilitate and value older workers.